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Journal of Economics, Business, and Accountancy Ventura Volume 15, No. 1, April 2012, pages 145 – 156 Accreditation No. 110/DIKTI/Kep/2009

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CORPORATE GOVERNANCE PRACTICES, SHARE OWNERSHIP STRUCTURE, AND SIZE ON EARNING MANAGEMENT

Hadi Sirat

Khairun University E-mail: [email protected]

Pertamina Gambesi Street Kampus II Unkhair Kecamatan Kota Ternate Selatan 97719, Maluku Utara, Indonesia

ABSTRACT

This study tries to analyze the effect of corporate governance practices, ownership, and firm size on the amount of earnings management. It was conducted in the companies listed in In-donesia Stock Exchange. Ownership structure can be divided into institutional ownership and family ownership, firm size which were measured by market capitalization. The corpo-rate governance practices were measured using three variables (quality audit, the proportion of independent board, and the existence of audit committee). Multiple-regression was em-ployed for analysis with the empirical data from 117 samples of manufacturing companies listed in the Indonesia Stock Exchange. It was found that company size and family ownership have a significant influence on the amount of earnings management. The larger the company, the smaller management is on average earnings and earnings management in the firms with high family ownership. Those that are not a corporate conglomerate are higher than average earnings in the management of other companies. The practice of corporate governance and institutional ownership variable did not have significant effect on the amount of profit made by company management. Key words: corporate governance, ownership structure, firm size, and earnings management.

PRAKTEK CORPORATE GOVERNANCE, STRUKTUR KEPEMILIKAN SAHAM, DAN UKURAN PERUSAHAAN PADA PENGELOLAAN LABA

ABSTRAK Penelitian ini bertujuan untuk menganalisis pengaruh praktik corporate governnance, ke-pemilikan, dan ukuran perusahaan terhadap jumlah earning management. Penelitan ini dila-kukan di perusahaan yang terdaftar pada Bursa Efek Indonesia. Struktur kepemilikan bisa dibagi menjadi kepemilikan institusi dan keluarga; ukuran perusahaan diukur dengan 3 variabel yaitu kualitas audit, proporsi dewan direksi independen, dan keberadaan komite audit. Multiple regresi digunakan untuk menganalisis data yang terdiri dari 117 perusahaan manufaktur yang tercatat di Bursa Efek Indonesia. Ditemukan bahwa ukuran perusahaan dan kepemilikan keluarga memiliki pengaruh signifikan terhadap jumlah earning manage-ment. Semakin besar perusahaan, semakin kecil earning management pada earnings rata-rata dan earning management di perusahaan yang nilai rata-ratanya lebih tinggi daripada kepemilikan keluarga. Perusahaan yang bukan konglomerat justru lebih tinggi earning man-agementnya. Praktik penerapan corporate governance dan kepemilikan perusahaan tidak berpengaruh secara signifikan terhadap earning management. Kata Kunci: corporate governance, struktur kepemilikan, ukuran perusahaan, dan penge-

lolaan laba.

ISSN 2087-3735 Corporate Governance Practices,… (Hadi Sirat)

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INTRODUCTION It is stated that a financial statement is a means of communicating financial informa-tion to parties outside the corporation. This financial statement is expected to provide information to investors and creditors for making decisions related to investment funds. In preparing financial statements, the accrual basis should be chosen because it is more rational and fair in reflecting the com-pany's financial condition in real terms. However, using the accrual basis may pro-vide more flexibility for the management in choosing the method of accounting so that they will not deviate from the rules of the Financial Accounting Standards.

In general, the choice of accounting methods that are deliberately selected by management for specific purposes is known as earnings management. When the man-agement did not succeed in attaining the tar-get profit specified, the management will take advantage of the flexibility allowed by the accounting standards in preparing their financial statement. This is done for modify-ing the reported earnings. Management should be motivated to show good perform-ance in generating value or the maximum benefit for the company. By doing so, they management can select and apply account-ing methods that can provide a better return. The existence of information asymmetry allows the management to create earnings management. Research by Richardson (1998) showed a positive relationship be-tween information asymmetry and earnings management.

One of measurements for corporate per-formance is often used as a basis for deci-sion making. Such a measurement is the company's profit generated (Subramanyam, 1996), where profit is measured by the ac-crual basis. Accrued profit is considered as a better measurement because the corporate databases must address satisfaction better than operating cash flows. This is because accruals reduces the time and mismatch problems (mismatching) embodied in the use of short-term cash flows (Dechow,

1994). Yet, the flexibility is always open in the

implementation of Generally Accepted Ac-counting Principles (GAAP) that leads man-agement to choose the accounting policies of the various policy options that exist. Thus, in turn, it also allows them to get for the flexi-bility of the earnings management by the company management (Subramanyam , 1996). In this case, Scott (2000) suggests that earnings management can make the companies efficient (increase in profit) and can be opportunistic. If earnings manage-ment is opportunistic, the information may lead to profit and make the wrong invest-ment decisions for investors. Therefore, it is imperative to see the factors affecting the profits of the company management.

This study attempts to provide empirical evidence on the impact of Indonesia's corpo-rate practice, ownership structure, and firm size on the magnitude of earnings manage-ment by the manufacturing companies listed in the Indonesia Stock Exchange.

It is also expected to contribute to the development of conceptual earnings man-agement literature, by adding independent variable, namely the ownership (combined with a business group). This is considered important when concerning the condition of the stock ownership in Indonesia. They have been dominated by family ownership, and this is different from the structure of share ownership in the United States whose own-ership is spread worldwide.

THEORETICAL FRAMEWORK It has been the fact that the research on cor-porate governance is increasing rapidly along with the opening of large-scale finan-cial scandals (e.g. Enron, Tyco, WorldCom and Global Crossing) involving accountants, one important element of good corporate governance. The scandals represent the negative consequences of weak governance system and seek to identify the determinants that can improve the implementation of cor-porate governance. Iskandar and Chamlou (2000), for example, stated that the eco-


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nomic crisis in Southeast Asia and other countries occurs not only due to macroeco-nomic factors but also weak corporate gov-ernance in those countries, such as weak legality of accounting standards and finan-cial inspection (auditing) that have not been established, capital markets that are still un-der-regulated, weak supervision of commis-sioners, and the neglect of the rights of mi-norities. Such a condition also indicates that good corporate governance has not only a positive result for shareholders, but also for the wider community in the form of national economic growth.

In the above circumstance, the various economic institutions and the financial world such as the World Bank and Interna-tional Monetary Fund are becoming inter-ested in the enforcement of corporate gov-ernance in recipient countries because they assume that corporate governance is an es-sential part of an efficient market system. Good corporate governance development efforts aimed at encouraging the optimiza-tion of the allocation or use of company re-sources for growth and prosperity of the owner of the company intact.

In this case, corporate governance is es-sentially a matter of controlling the behavior of top corporate executives to protect the interests of company owners (shareholders). This problem arises because of the separa-tion between ownership and company man-agement. The owners of the company as suppliers of capital can delegate their author-ity of the management of the company to professional managers. As a result, the au-thority to use corporate resources is entirely in the hands of the executive. Shareholders expect management to act in a professional to manage the company. Any decision taken should be based on the interests of share-holders and existing resources used solely for the sake of growth (value) of the firms.

However, what often happens is that the decisions taken by management are not solely for the benefit of the company but also for the interests of executives. In fact, in many cases, decisions and actions taken

have only often become the benefits but also harms for the corporate executives. In other words, management has an agenda which is different from the interests of the owners. The use of creative accounting, business failures, limited roles of auditors, the ab-sence of a clear relationship between com-pensation and the performance of the sys-tem, emphasis on performance (accounting profit) at the expense of short-term long-term economic profits, and so on (Keasey and Wright, 1997) are some examples of the behavior deviations manager.

In general, corporate governance is the means, mechanisms, and structures that serve as control over self-serving behavior of managers (Short et al., 1999). The man-agement of the companies that are open (transparent) and accountable can prevent the occurrence of self-serving behavior. As revealed by Keasey and Wright (1997) that the corporate governance is a key element that concern the enhancement of corporate performance via the supervision, or monitor-ing, of management performance and ensur-ing the accountability of management to shareholders and other stakeholders.

Thus, Good corporate governance can be defined as an interaction between struc-tures and mechanisms which ensure control and accountability, but still encourage effi-ciency and performance of the company (Sa-lowe, 2002). Anderson et al (2002) also stated that the company controlled by the family has a structure that reduces the agency conflict between shareholders and creditors, which the lender assumes the ownership by the family better, protect the interests of creditors. Anderson & Reeb (2002) showed that minority shareholders would benefit from the presence of family ownership. Arifin (2003) found that the pub-lic companies in Indonesia, family-controlled financial institutions or state or agency problems are better than a public company controlled by or without the main controller.

Family-controlled firms, a smaller agency problem is due to reduced conflicts


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between principal and agent. If family own-ership is more efficient, the family holdings in companies with high earnings manage-ment which is opportunistic may be re-stricted. However, the more efficient of the control of the family's ownership it likely does not apply in the conglomerate, as it is widely available in Indonesia. For the con-glomerate, usually most of the property owner does not reside in one company, but scattered in various companies.

If only a few property owners who are in companies that go public, so even if the company goes public, they are still a family controlled, but the opportunistic earnings management can be even higher. The possi-bilities for companies that go public are only used as a means of collecting funds from the public for use by the company. This is evi-dent from the results of research Kim & Yi (2004) who found that the magnitude of earnings management is higher for compa-nies that have affiliate group than those that do not have group or no affiliation. This means that firms with business group affilia-tion provides controlling shareholders more incentive and opportunity for earnings man-agement.

It is advisable that the company should be controlled by the family and not a corpo-rate conglomerate that can limit opportunis-tic earnings management (negatively re-lated), but will drive earnings management that is efficient (positively related). Institu-tional investors often referred to as sophisti-cated investors and should be able to use the current period information in predicting fu-ture earnings as compared to non-institutional investors. Balsam et al (2002) found a negative relationship between dis-cretionary accruals that are not expected to yield stocks around the announcement date, which is a negative relationship, varies de-pending on the level of investor sophistica-tion.

The market reaction of the more sophis-ticated investors precedes that of unsophisti-cated investors. Jiambalvo et al (1996) found that the absolute value of discretionary ac-

cruals is negatively related to ownership of institutional investors. Mitra (2002), Koh (2003), and Midiastuty &. Machfoedz (2003) also found that the presence of high institutional ownership limits managers to manage earnings. However, Darmawati (2003) found no evidence of an association between earnings management and institu-tional ownership. If earnings management is done efficiently, the high institutional own-ership would likely improve the earnings management (positively related). On the contrary, if the management of the company profits are opportunists, the high institutional ownership will reduce earnings management (negatively related).

The larger the company, the better the information available to investors in making investment decisions with respect to the shares of the company. Albrecth & Richard-son (1990) and Lee & Choi (2002) found that larger firms have less impetus to do profit smoothing than small firms because large firms are seen as more critical by out-siders. Therefore, the expected size of the company can affect the amount of earnings management, in which when the of earnings management is opportunistic is higher, the company’s earning management is also bet-ter (negatively related), but if the efficient management of the greater profit of the company size, the higher the earnings man-agement is (positively related).

Dechow et al (1996) in his research shows that companies manipulate earnings are more likely to have a board dominated by management and are more likely to have major directors who concurrently become commissioner. Chtourou et al (2001) and Wedari (2004) found that the independent board would restrict earnings management activities. However, Parulian (2004) found that the independent commissioner compa-nies on the JSE are not found to significantly affect the management of corporate profits.

Klein (2002) found that the magnitude of discretionary accruals is higher for firms that have audit committees composed of in-dependent commissioners less than compa-


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nies that have audit committees composed of many independent commissioners. Wedari (2004) finds that discretionary accruals in companies that do not have audit committees significantly higher than the companies that have no audit committee.

While Parulian (2004) concluded that audit committees have a significantly nega-tive relationship with negative discretionary accruals, but not significantly associated with positive discretionary accruals. Other studies on audit committees indicate the ex-istence of audit committees which are less effective as one of the practice of corporate governance in companies listed on the JSE. Mayangsari (2003) investigated the influ-ence of the existence of an audit committee for the integrity of financial reporting (as measured by the index of conservatism). It showed that the existence of audit committee was negatively related to the integrity of fi-nancial statements.

Unlike Nuryanah (2004), she found that audit committee did not significantly affect the value of the company. A system of cor-porate governance in companies believed to limit the opportunistic earnings manage-ment. It is due to the fact that it is expected with higher audit quality, the higher the pro-portion of independent board and audit committee of the less opportunistic earnings management (negatively related). However, if earnings management is efficient, it will be the opposite (positively related). RESEARCH METHOD The population consists of all the manufac-turing companies listed on the Indonesia Stock Exchange with total of 157 units. These were selected based on purposive sampling method, and 117 units of the com-panies were taken as the sample, during 5 years, from 2002 to 2007.

These quantitative data were obtained from the capital market reference center, in the form of financial statements issued by companies listed on the Stock Exchange, Indonesian Capital Market Directory and Listing of Securities Exchange (DKE). In

addition to determining whether the sample is a conglomerate company or not, it was determined through a survey of the literature books (such as Conglomeration Indonesia (2002) and Top Companies and Big Groups in Indonesia (2002).

The multiple regression was used to ana-lyze the influence of corporate governance practices, ownership, and firm size towards the magnitude of earnings management. The formulation of the multiple regression mod-els is as the following: Y=α + β1NAA + β2PKK + β3PPI + β4NLP + β5AUD + β6MDD + β7KAD + β8RTH + β9RPM + ε, (1) where: NAA = absolute value of discretionary ac-

cruals. It is because this study is the amount of earnings management (discretionary accruals), rather than the direction (positive or negative).

PKK = 1 if firms have high family owner-ship (the proportion of family own-ership> 50%) and they are not a conglomerate and 0 otherwise.

PPI = proportion of institutional investor ownership.

NLP = Natural logarithm of market capi-talization.

AUD = If the companies audited by Big 4, they are given values 1 and 0 if oth-erwise.

MDD = proportion of independent board. KAD = If the company has an audit com-

mittee in compliance with BEI, it is given a value of 1 and 0 if other-wise.

RTH = Ratio of total debt to total assets. RPM = Sales growth. Operational Variables Profit Management Total accruals (ACCR) is measured as the difference between net income before ex-traordinary items and operating cash flow (ACCR = EARN - CFO). This is to decom-pose total accruals into discretionary and non discretionary component of the formula-tion used (Dechow et al, 2002).


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Family Shareholding The whole sample is classified into families of high ownership (the proportion of family ownership> 50%) and low family ownership (the proportion of family ownership <50%). After this, it created a dummy variable for family ownership, which is 1 if the company that has high family ownership and not a conglomerate and 0 otherwise. Institutional Ownership Institutional ownership is the ownership of shares by financial institutions such as insur-ance companies, banks, pension funds, and investment banking. Company Size Firm size is measured by natural logarithm of firm equity market value at the end of the year, the number of shares outstanding at year end are multiplied by the price of the stock market by year end. Corporate Governance Practices This study used three proxies of corporate governance practices such as (1) Firm Size, used to measure the quality audit, which the companies are audited by Big 4 (public ac-countant office or large KAP) then it is he high-quality audits and if audited by non Big 4 (small KAP), it is the low audit quality, (2) The proportion of independent board is cal-culated by dividing the number of independ-ent board members to total board. Informa-tion on the number of independent commis-sioners can be obtained from the annual re-ports of each company, Indonesian Capital Market Directory, and also of the an-nouncement issued by the JSE, and (3) The existence of the Audit Committee, which is to determine whether the company has an audit committee or not will be checked in The annual report of each company and an-nouncements issued by Indonesia stock ex-change. DATA ANALYSIS AND DISCUSSION Testing the hypothesis in the study is valid when based on valid data or information,

and the information is also valid if obtained from the data quality. Data contain outliers if the data are biased and not qualified. The test to determine whether there is data out-lier in this study, with methods of descrip-tive statistics (Descriptive Statistics). The results showed that all research variable mean values were greater than the standard deviation, so that all variables contain no data outliers (Table 1). Therefore, all vari-ables used in this study were analyzed to prove the hypothesis is feasible.

It showed that the average discretionary accrual is 0.0462 and the standard deviation is 0.0364. This suggests that earnings man-agement among firms that do the variations is still quite high. Institutional ownership is relatively small at only 2.63%. Only 21.42% of the sample firms have a high family own-ership and not a corporate conglomerate. Most of the sample firms (89.27%) were audited by Big 4. Family shareholding (PKK), proportion of institutional investor ownership (PPI), and KAP Audit by Big 4 (AUD) significantly correlated with the magnitude of earnings management (NAA).

Family shareholding (PKK) and the pro-portion of institutional investor ownership (PPI) are negatively correlated. This is be-cause the measurement of family sharehold-ing (PKK) uses a dummy variable where 1 for firms with high family ownership and is not a conglomerate and the public if the conglomerate has a size larger than the com-pany's non-conglomerate firms.

The proportion of institutional investor ownership (PPI) and the Natural Logarithm of Market Capitalization (NLP) were posi-tively correlated, where it shows a lot more institutional investors to invest in large com-panies than in small firms. Audit by Big 4 Firm (AUD) and the proportion of inde-pendent board (MDD) were positively corre-lated; meaning that companies have an audit committee also have a high proportion of independent commissioners. Natural loga-rithm of market capitalization (NLP) and KAP Audit by Big 4 (AUD) are positively correlated, meaning that large enterprises are


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more frequently used than KAP KAP Non Big 4 Big 4.

The test results with the regression model (Table 2) shows as the following. 1. At a significance level of 5% on average earnings in the company's management with high family ownership (PKK) and not a conglomeration of companies which is sig-nificantly higher than average earnings in the management of other companies , with p-value 0.037; 2. The proportion of institutional investor ownership (PPI) negatively affect the magni-tude of earnings management with a p-value of -0.063, 3. NLP has a positive influence on earnings

management, but no significant influence on the amount of earnings management (NAA), with p-value 0.246. These results are consis-tent with the results of the study Darmawati (2003) who also found no evidence of a sig-nificant relationship between earnings man-agement with institutional ownership, 4. Natural logarithm of market capitalization (NLP) has a significant negative impact on earnings management, with a p-value -0.017. This means that the larger the company will be smaller profits made by company man-agement. These results are consistent with the findings of Lee & Chai (2002), in which small firms are more likely to manage earn-ings than large companies,

Table 1 Descriptive Statistics

Variabel Mean Std. Deviation N NAA 4.313 0.642 117 PKK 4.402 0.542 117 PPI 4.467 0.562 117 NLP 4.415 0.673 117 AUD 4.062 0.759 117 PDK 3.567 0.533 117 KAD 3.628 0.519 117 TRH 4.326 0.674 117 PPJ 3.429 0.528 117

Table 2

Results of Testing by Multiple Regression Model

Independent Variabel Coefisient of Regression T-test Statistics Sig.

Partial

Constant 1.141 5.644 0.074

PKK 0.462 6.436 0.037 PPI -0.473 1.111 -0.063 NLP -0.415 2.196 -0.017 AUD 0.181 3.409 0.524 PDK 0.290 4.053 0.309 KAD -0.257 2.318 -0.204 RTH 0.364 4.637 0.104 PPJ 0.403 3.032 0.542

Source: Data processed


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5. Audit by Big 4 Firm (AUD) has a nega-tive effect on earnings management, but no significant effect on the management earn-ings, with a p-value 0.524; 6. The proportion of the board of commis-sioners (PDK) and do not have a significant positive influence on earnings management, with a p-value 0.309; 7. Audit by Big 4 Firm (ADK) has a nega-tive effect and no significant of earnings management, with a p-value -0.204, and; 8. The variable ratio control total debt to total assets (RTH) has no significant positive effect on earnings management with a p-value 0.104. The test results are consistent with the debt covenant hypothesis. While sales growth variables (RPM) have negative but not significant effect with p-value 0.542. CONCLUSION, IMPLICATION, SUG-GESTION, AND LIMITATIONS Company size variables consistently had a significant negative effect on the amount of earnings management by the company, meaning the larger the size, the smaller the amount the management company's profits. In addition, the average earnings manage-ment in companies with high family owner-ship and not a conglomerate, they are sig-nificantly higher than average earnings in the management of other companies.

It is suggested that researcher should conduct research focused on developing the model of measurement in earning manage-ment. It should be done more accurately such doing per industry. So, the industry characteristics which are different may in-fluence earning management and this should be included in the research model. By doing so, it can identify the difference of manage-ment of earnings in every industry. Developing instrument of measurement for calculating the index of corporate govern-ance of public companies in Indonesia. Doing research on the effect of independent board proportion and the existence of audit committee towards the earning management for the longer period. Further research also identify which ac-

counts the companies often do the earning management. Thus, it can also provide rec-ommendation which is more specific to-wards standard setter for adding disclosures and towards investors for paying more atten-tion to those accounts.

This study found evidence that earnings management in family-controlled company and not a corporate conglomerate is higher than earnings management in other compa-nies. This can be indicative of earnings man-agement taken by family-controlled com-pany and not a conglomerate is more effi-cient than the other companies. Looking at the fact that the numbers of public compa-nies are conglomerates, this study can be the input to the regulator to supervise the com-pany's more on conglomerates, whose own-ership is concentrated in one or a few par-ties.

Company size was proven to have sig-nificant negative effects of the magnitude of earnings management, indicating that the smaller the company the greater the earnings management is carried out. This could indi-cate that earnings management do small firms are not efficient. Therefore, the smaller the size of a company, the more control needs to be done by the regulators of small companies, without the supervision of the company's light great companies. Since there is a possibility, not all larger companies are increasingly to open opportunistic earnings management for earnings management in large companies that have been planned more than just using the accrual policy, mak-ing it more difficult to detect.

Quality audit, which using KAP size, the main test is shown to have significant influ-ence on earnings management practices that are carried out by the management. Most of the public have the perception that large-scale KAPs can provide high quality audit. The results in this study can be stated that the public perception is less precise, because the companies which are audited by big profits are not shown to limit the manage-ment of the company.

A high proportion of independent com-


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missioners and the existence of audit com-mittees are not shown to limit the profits of the company management. There are several possible explanations for this. First, the ap-pointment of an independent commissioner and the company's audit committee may only be carried out for regulatory compli-ance but are not intended to enforce good corporate governance (GCG) in the com-pany.

Second, the minimum requirement of an independent board of 30% may not be high enough to cause the independent commis-sioner to dominate the measures taken by the board of commissioners. When the inde-pendent commissioner is a party to the ma-jority that is > 50%, it may be more effective in carrying out the monitoring role within the company. But, if the appointment has not been based on the needs (needs) of the com-pany but was limited to the fulfillment of regulations, then the proportion of the board of commissioners may not need to be cop-ied, fixed in accordance with existing regu-lations (at least 30%), and viewed the effec-tiveness of the board and audit committee is also in a longer period of time.

In order for the appointment of an inde-pendent commissioner and the company's audit committee is not limited to compliance with any regulation, the regulators need to think of ways to better disseminate the need for enforcement of good corporate govern-ance. Suppose, as a survey conducted by the GCG and to reward companies with good corporate governance best. The regulator may also publish writings that show evi-dence that companies implementing GCG obtain a positive reaction from the market, so it can grow in the company that needs to implement good corporate governance. In addition, for companies those have not raised an independent commissioner and in compliance with audit committees, they may also be subject to strict sanctions.

The present study also found that firm size negatively affects the magnitude of earnings management. This means that the smaller the company, the greater the earn-

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